Self-Directed IRA (SDIRA): How it Works and How to Open One
Self-directed IRAs have become more popular in recent years with investors seeking greater control over their investments. They aren’t for everyone, however, given the complex rules and risks associated with them. This article discusses just that.
What is an IRA?
Before we dive into SDIRAs, let’s make sure you have a firm grasp on IRA basics. Simply defined, an IRA is an account designed specifically to help fund your retirement. Two primary types for investors include Roth and traditional IRAs, both of which offer considerable tax breaks. The difference, however, is just a matter of when you receive them.
A traditional IRA is a tax-deferred account, meaning you’ll pay taxes on a future date; contributions are typically funded with pre-tax dollars, and earnings grow tax-deferred until you make a withdrawal during retirement. Tax breaks come later with a Roth IRA as contributions are funded with after-tax dollars. Your money grows tax-free in this case, and you can make tax-free withdrawals in retirement provided you’ve owned the account for at least five years.
What is a self-directed IRA?
A self-directed IRA (SDIRA) is a type of IRA that allows you to invest in a broader range of investments within the account, holding more than just stocks, bonds, exchange-traded funds (ETFs), and mutual funds (types of assets held in a typical IRA). With SDIRAs, you can invest in commodities, real estate, cryptocurrency (e.g., bitcoin and dogecoin), and precious metals—investments typically shut out of traditional and Roth IRAs.
Self-directed IRAs can be structured as either a Roth or traditional IRA, with the account holder directly managing investments though a custodian or trustee does administer the account (hence the name “self-directed”).
Self-directed IRA advantages
Many people choose to open a self-directed IRA primarily to pursue higher investment returns and achieve greater diversification while still benefiting from the tax advantages traditional and Roth IRAs offer. This method gives you complete control over the investments in your account and thus an improved ability to achieve your financial goals. For example, if you’re knowledgeable about investing in various categories—such as a private company, livestock, tax lien certificates, or undeveloped land—you have the freedom to select which investments to pursue in these arenas and how to allocate funds.
Self-directed IRA risks
While owning an SDIRA comes with many benefits, you should also familiarize yourself with potential risks before opening an account. These include:
Complex rules
If you break a rule, the IRS considers the account as having ceased to function as an IRA—perhaps resulting in an early distribution for the entire account, meaning you’ll need to pay taxes on the full amount and perhaps a penalty as well. Let’s say you have a rental property investment through your SDIRA, for example. Rules dictate you’re not allowed to withdraw money from the account to fix any issues that arise within that property (e.g., a broken window) as doing so would violate the “self-dealing” rule. Visit the IRS website for a complete list of prohibited transactions.
Due diligence on you
You’re responsible for conducting due diligence for every investment, especially since SDIRA custodians aren’t responsible for verifying investment legitimacy or claim accuracy (nor are they allowed to offer financial advice for such investments).
Higher potential for fraud
SDIRAs have a higher risk of fraud than their counterparts. In fact, the Securities and Exchange Commission (SEC) recently issued an investor alert concerning potential fraud risk in self-directed IRAs.
Lack of liquidity
SDIRAs have lower levels of liquidity. For example, it’s much easier to pull out of stocks, bonds, and mutual funds than it is to do so for real estate or livestock investments. This is sometimes a concern, particularly with respect to required minimum distributions (RMDs) for SDIRAs established as traditional IRAs; in the absence of liquidity to distribute the funds, you can get hit with a penalty from the IRS if you don’t take distributions on time. A Roth SDIRA doesn’t have the same restrictions, though liquidity can eventually present an issue when a beneficiary inherits the IRA and must liquidate it within a 10-year period.
Fees
While these vary, fee structures are often more complicated and steeper with SDIRAs than Roth and traditional IRAs.
How to open a self-directed IRA
Opening a self-directed IRA is as easy as setting up any other type of IRA once you find a custodian to hold the account. Most household-name brokerage firms don’t offer self-directed IRAs, as SDIRA custodians are often trusted companies and some banks. While these companies are approved by the IRS (see these approved non-bank trustees and custodians), they provide fewer protections and little to no oversight compared to traditional and Roth IRA custodians. Your best resource in this respect, therefore, is a financial advisor who can direct you to a trustworthy custodian for your SDIRA so you can then fund it—just as you would any other IRA.
In sum: what to know about self-directed IRAs
Self-directed IRAs aren’t for everyone, as they’re best suited for confident and sophisticated investors who can better diversify their funds and ultimately earn higher returns. For most investors out there, a regular IRA is just fine.
Still have questions about self-directed IRAs? Schedule a FREE discovery call with one of our CFP® professionals to get them answered.
FAQs
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A recent Tax Policy Center estimate reports that over 60 million Americans own an IRA, totaling over $9.4 billion in assets. The overwhelming majority of these are comprised of well-known options such as Roth, traditional, SEP, and SIMPLE IRAs; a closer look reveals that only 3% to 5% reflect self-directed IRAs (SDIRAs), per the Retirement Industry Trust Association.
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Self-directed IRA contribution limits mirror those of regular IRAs: $7,000 (for 2025), though those age 50+ can tack on an additional $1,000.
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Self-directed IRAs are subject to the same withdrawal rules and regulations as standard IRAs. For example, as with a Roth IRA, you’ll be taxed if (in retirement) you withdraw from the earnings portion of the account and have only held the account for less than five years.
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While self-directed IRAs offer much leeway with respect to investment type, the IRS does prohibit some transactions including life insurance and collectibles such as gems, coins, stamps, art, antique, and rugs. Furthermore, you cannot place investment money with disqualified people including family members or a fiduciary (such as a financial advisor): a rule meant to protect investors from scams/manipulation and ensure the IRA is used for retirement.
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No; the IRS prohibits borrowing money from a self-directed IRA.
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Disclosures:
This document is a summary only and is not intended to provide specific advice or recommendations for any individual or business.
